Growth recovery visible; sentiment poor

Policy actions could be increasingly populist in nature as the BJP drives towards getting re-elected

The Q3 GDP data indicates that there is some sort of growth recovery. In turn, this suggests that the impact of the Goods and Services Tax (GST) implementation is easing off. Growth through 2018-19 should be better. There are caveats. The banking system looks to be under severe stress. The fiscal deficit is likely to expand. The US president may also just have triggered a trade war that cuts into optimistic projections for global growth.

The October-December 2017 quarter saw GDP growth running at 7.2 per cent. This is the highest since JulySeptember 2016. The growth rate for July-September 2017 was also revised upwards. The nine-month period April-December 2017 saw GDP growth at 6.5 per cent. The full-year growth could touch 6.7 per cent.

The first caveat though is the low base effect created by poor growth in October-December 2016 when demonetisation led to GDP growth dropping to 6.1 per cent. Against that, there are several numbers that suggest that the uptrend is genuine. For example, core sector growth was 6.7 per cent during the quarter, corporate results showed both sales and profit expansions and vehicle sales grew substantially.

Recovery in the fast moving consumer goods sector also indicated that private consumption may have pulled out of a trough. The Index of Industrial Production (IIP) across AprilDecember stood at a moderate growth level of 3.7 per cent. Construction showed an uptick of 6.8 per cent, which would be associated with more investment. This signal is backed by growth in gross fixed capital formation (GFCF) by 12 per cent in Q3.

On the downside, the Reserve Bank of India (RBI) looks set to raise interest rates, rather than to cut. Hikes could be forced upon the central bank by rising inflation and indeed, good growth numbers could also provoke the RBI to hike. The monsoon will be one key critical factor to consider. Another possible inflationary factor is higher crude prices.

In any event, commercial rates are likely to stay high and bond yields are signalling a bearish scenario. There are fears that a rising fiscal deficit will lead to higher government borrowing and crowd out private borrowing. One poor signal for Q4 was the contraction indicated in the services PMI which dropped into negative territory. Manufacturing PMI showed slower growth as well.

Quite apart from domestic considerations, the rupee is also under pressure as the US Federal Reserve might look to hike USD rates early. The stance of the European Central Bank (ECB) and the Bank of Japan (BoJ) will become clearer this week as both central banks have policy meetings. Given decent growth, both banks could opt to cut back on their respective ongoing quantitative easing programmes and/or to hike interest rates which are currently in negative zones.

The market consensus, however, is that both the ECB and BoJ will wait for more clarity about the impact of an incipient trade war. Donald Trump has shocked the market by placing big protectionist tariff barriers on metal imports and the Europeans may retaliate by tariff barriers on US goods. That would lead to a rise in global inflation indices and lower growth.

The scam at the Punjab National Bank has now crossed the ~120 billion mark and similar scams are being unearthed across the banking system. Obviously this is bad for sentiment. Given the poor Q3 results of banks, and the draconian tightening of norms for recognition of non-performing assets (NPAs), the NPA situation is likely to get worse.

The ultimate cost of recapitalisation is likely to be at least twice as high as the projected ~2.2 trillion. On the other hand, it is possible that better corporate results will translate into better repayment of loans. At any rate, public sector banks are likely to be wary of big-ticket lending through the first half of 2018-19. Lower credit on offer could hurt growth.

There is already some political fallout from this crisis and there could be more. The new bill targeting the assets of economic offenders who have absconded looks to be a knee-jerk response. It remains to be seen if this will actually translate into concrete action.

Sentiment remains rather poor. FPIs sold through February and they have sold in the rupee debt market as well. Domestic institutions remained net positive in February though they sold in the only session of March for which data is available. Retail investors have been net sellers in direct equity but they have continued to push money into mutual funds, via locked-in SIPs.

Sentiment is likely to be very heavily driven by electoral considerations. Policy actions could be increasingly populist in nature as the BJP makes its drive towards getting re-elected. The market won't like that. But investors would be even more spooked by the possibility that the BJP will not retain power. Right or wrong, it is seen as more business friendly and the Prime Minister's personal popularity exceeds that of any other individual.

The technical position is shaky. Persistent selling has meant that the Nifty is testing support at the 10,27510,350 zone. If it breaks down below that level, it would test the 200-Day Moving Average at 10,100 or so. If the 200 DMA does break, that could signal a long bear market.